Monday, January 31, 2011

Japan’s Credit Rating Downgrade a Symptom of Continued Economic Woes


This week Standard & Poor’s downgraded Japan’s government bond ratings because of insufficient government efforts to improve Japan’s economic performance and decrease national debt. Over the past decade, Japan’s economy has struggled with deflation and anemic economic growth. Japan’s total sovereign debt now stands at $11 trillion (943 billion Yen) and the downgrade announcement comes at a time when Japan is attempting to overhaul its tax and social security systems.

Standard & Poor’s lowered its rating of Japan’s long-term government bonds from AA to AA-. A bond rating reflects the quality and safety of a bond and a downgrade indicates that investors have less confidence that a borrower will meet its repayment obligations. Once a country’s debt has been downgraded, investors normally require a country to pay higher interest rates to account for the increased risk.

Japan differs from many countries in that 95 percent of its government bonds are owned by Japanese citizens and institutions, so even if the downgrade frightens foreign investors, there will likely be little impact on its bond market. In contrast, at the time of Greece’s crisis, 70 percent of its sovereign debt was held by foreign investors. Because of this distinction, Japanese markets have reacted calmly and media attention has been relatively light compared to other recent government bond downgrades.

Credit rating agencies themselves have been criticized in their handling of sovereign debt ratings. The Secretary General of the Organization for Economic Cooperation and Development (OECD) complained that ratings agencies exacerbate the economic instability of the countries they rate by quickly downgrading without warning and not working together with governments to share the concerns of bond investors. This is also not the first time Japan’s rating has been cut. In 2002, its credit rating was significantly cut, but the downgrade had no effect on long-term interest rates.

Discussion Questions:

  1. Are bond ratings agencies in effect giving policy prescriptions to lawmakers when they downgrade ratings?
  2. What other factors contribute to the media giving European bond downgrades much more attention than Japan’s?

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